Compliance and Regulatory Alerts - 06-30-20

SEC Approves FINRA Amendments on Suitability and Non-Cash Compensation Rules

The SEC has approved final FINRA amendments to its rules on suitability and non-cash compensation. The final amendments ensure that FINRA’s rules line up with the SEC’s Regulation Best Interest (Reg BI). The FINRA rule changes became effective today, June 30th, 2020, the same date as Reg BI.

As Bates described previously, FINRA proposed these amendments in order to clear up any confusion that the preexisting rules may present concerning the go-forward standards that apply to broker-dealer recommendations to retail customers. A recent FINRA Notice on oil-related exchange traded products (see here for a recap) suggests that FINRA remains concerned that firms understand the applicability of pre-existing suitability rules to complex products under the new Reg BI standard. In this article, we review the final FINRA rule changes.

Key Rule Changes

The specific changes affect FINRA Rule 2111 (Suitability), Rule 2310 (Direct Participation Programs), Rule 2320 (Variable Contracts of an Insurance Company), Rule 2341 (Investment Company Securities), Rule 5110 (Corporate Financing Rule - Underwriting Terms and Arrangements), and Capital Acquisition Broker Rule 211 (Suitability).

Suitability

FINRA’s final rule was explicit—the suitability rule will not apply to recommendations subject to Reg BI. FINRA’s reasoning is as follows: (i) Reg BI’s care obligation, one of four enhanced obligations about to go into effect, addresses “the same conduct with respect to retail customers that is addressed by Rule 2111, but employs a best interest, rather than a suitability standard;” (ii) as a result, compliance with Reg BI “necessarily” meets the suitability standards under Rule 2111; and (iii) the rule change effectively eliminates what would otherwise be duplicative compliance obligations.

FINRA’s rule changes also include applying the newly explicit language on suitability to FINRA’s Capital Acquisition Broker Rules. That is, the suitability rule “shall not apply” to capital acquisition broker recommendations subject to Regulation Best Interest.

FINRA’s suitability rule requires a three-part compliance obligation: reasonable basis suitability, customer specific suitability and quantitative suitability. According to FINRA, this is all subsumed under Reg BI’s enhanced care obligation. However, the final rules did formally remove the “element of control from the quantitative suitability obligation,” an action meant to address instances of excessive trading in a customer’s accounts.

FINRA is not getting rid of the suitability rule—it is still needed for entities and institutions like pension funds, as well as for natural persons  who do not use recommendations for personal purposes (such as small business owners or charitable trusts.) Suitability also remains viable under other FINRA rules such as Members' Responsibilities Regarding Deferred Variable Annuities  (FINRA Rule 2330) and options (FINRA Rule 2360) where the existing rules have a suitability or suitability-like component.

Non-Cash Compensation

The approved final changes adjust FINRA rules to apply Reg BI’s conflict of interest limitations on sales contests, sales quotas, bonuses, and non-cash compensation. Under prevailing rules, FINRA had required broker dealers to have written policies designed to identify and eliminate any program that is based on the sales of specific securities or specific types of securities within a limited time period. Under the final rules, FINRA will not permit non-cash compensation arrangements that conflict with Reg BI, specifically under its rules governing direct participation programs, variable contracts for insurance companies, investment company securities, and corporate financings.

 

For more information, visit Bates Compliance online at www.batescompliance.com and the Bates Reg BI service page, as well as our educational training center for Reg BI and Form CRS webinars on demand and customized firm training.

Please do not hesitate to reach out:

Robert Lavigne, Managing Director, Bates Compliance

Julie Johnstone, Managing Director, Retail Securities Litigation

Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations

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